The Foreign Office has refused to deny it is considering withdrawing its ambassador to Israel over Prime Minister Benjamin Netanyahu's decision to expand settlement building, in the wake of the Palestinian Authority's successful bid for statehood at the United Nations.

The Israeli ambassador to the UK Daniel Taub has been officially summoned to the Foreign Office.

A Foreign Office spokesperson said in a statement: "We deplore the recent Israeli government decision to build 3,000 new housing units and unfreeze development in the E1 block. This threatens the viability of the two state solution.

“We have called on the Israeli government to reverse this decision. The Israeli Ambassador to London, Daniel Taub, has been formally summoned to the Foreign Office this morning by the Minister for the Middle East, Alistair Burt. The Minister set out the depth of the UK’s concerns.

“Any decision about any other measures the UK might take will depend on the outcome of our discussions with the Israeli government and with international partners including the US and European Union.”

“Israeli settlements are illegal under international law and undermine trust between the parties. If implemented, these plans would alter the situation on the ground on a scale that makes the two state solution, with Jerusalem as a shared capital, increasingly difficult to achieve.

"They would undermine Israel’s international reputation and create doubts about its stated commitment to achieving peace with the Palestinians.

"The UK strongly advises the Israeli Government to reverse this decision. The window for a two-state solution is closing, and we need urgent efforts by the parties and by the international community to achieve a return to negotiations, not actions which will make that harder.”

The British embassy in Tel Aviv told Reuters: "The recent Israeli government decision to build 3,000 new housing units threatens the two-state solution and makes progress through negotiations harder to achieve," the British embassy in Tel Aviv said.

"We have called on the Israeli government to reconsider."

British ambassador Matthew Gould has been in Israel since 2010. He has been vocal in his opposition to settlements, telling Israel's Channel 10 News in August that he believed attitudes towards Israel had shifted in parliament.

"Israelis might wake up in 10 years' time and find out that the level of understanding in the international community has suddenly changed, and that patience for continuing the status quo has reduced," he said.

"Support for Israel is starting to erode and that's not about these people on the fringe who are shouting loudly and calling for boycotts and all the rest of it.

"The interesting category are those members of parliament in the middle, and in that group I see a shift."

A view of the Jewish West Bank settlement of Maaleh Adumim, near Jerusalem

Israel's Vice Prime Minister Moshe Yaalon told Israeli Army Radio he was not aware of any recall.

"I did not hear of this, either via the foreign ministry or the prime minister's office. Therefore I have a hard time believing it is true," he said.

Reuters reported that the French Foreign Minister Laurent Fabius had told them: "There are other ways to show disapproval of Israeli settlements than recalling ambassadors."

Israel also announced on Sunday it was withholding Palestinian tax revenues from November worth about £50 million, which the government said was a contribution towards a Palestinian debt of £100 million with the Israeli Electric Corporation.